I am the director of the Tax Policy Center (TPC), Paul Volcker Professor of Public Administration and International Affairs at the Maxwell School of Syracuse University, and a research associate at the National Bureau of Economic Research and the Center for Policy Research. My research focuses on federal tax and budget policy. In 2002, I co-founded the TPC. I served several stints in government, including as Deputy Assistant Secretary for Tax Analysis at the US Treasury and Senior Analyst at the Congressional Budget Office. I was president of the National Tax Association from 2010-2011. I have a Ph.D. in economics from the University of Minnesota and a B.A. from Wesleyan University. I have four adult kids and am married to my college sweetheart, Missie Burman. I'm an avid bicyclist and sing baritone in the Syracuse Oratorio Society. I also like to cook.

The author is a Forbes contributor. The opinions expressed are those of the writer.

Billions in Tax Refund Fraud--and How to Stop Most of it

The Treasury may be losing as much as $5 billion a year from fraudulent tax refund claims—and most of that fraud is entirely preventable.

The New York Times reported yesterday about the rampant use of identity theft to exploit weaknesses in the IRS’s tax refund processes, sometimes resulting in thousands of fraudulent refunds.

The most common form of fraud simply requires criminals to obtain a valid name and social security number, preferably from someone who won’t be filing a tax return. Then the criminal makes up wage and withholding information, files a tax return electronically (avoiding the need for an actual W-2 form), claims a few deductions and tax credits to produce a larger refund, and waits a couple of weeks for the refund.

Typically, the refunds are deposited electronically—often multiple refunds to the same account. In one especially egregious example, J. Russell George, the Treasury Inspector General for Tax Administration (TIGTA), testified about 4,157 “potentially fraudulent tax refunds … totaling $6.7 million … deposited into one of 10 bank accounts. Each … account had direct deposits of more than 300 refunds.”

The criminals also use debit cards to claim fraudulent refunds. The New York Times reported that swindlers in Florida use addresses for vacant houses (in ample supply), sometimes “even buying mailboxes for them, and collect the refunds there.”

The IRS has taken steps to stem the fraud. For example, it tries not to send refunds to dead people. All told, the IRS claims that it was able to stop $1.3 billion in potentially fraudulent returns through April 19, 2012.

But with massive budget cuts ($300 million this year) and pressure from Congress to process tax refunds quickly, the IRS is fighting a losing battle. Mr. Russell, the Treasury Inspector General, identified 1.5 million additional potentially fraudulent refunds totaling in excess of $5.2 billion that slipped through the cracks.

With appropriate resources and legislative authority, the IRS could prevent most of these refunds. For the past four years, it has sought authority to use the National Directory of New Hires, a database of wage and employment information maintained by the Department of Health and Human Services, to verify that information on tax returns actually corresponds to a real job. This would limit the ability of fraudsters to make up W-2’s, but so far, Congress has not granted the IRS the authority to use that information.

The ideal solution would be for the IRS to be able to match W-2 information with tax returns before processing a refund, but W-2’s are not due until the end of March (if filed electronically, February otherwise) and they go to the Social Security Administration (SSA) rather than IRS, which further delays availability of information to the IRS. If W-2’s were required to be transmitted to the SSA at the same time they were sent to workers and if SSA and IRS computers could talk to each other in real time, most of the refund fraud would be impossible. Obviously, this would put an additional burden on employers and some costly upgrades at SSA and IRS, so using the National Directory should be tried first.

Mr. George also said back in 2008 that “the IRS was not in compliance with direct deposit regulations that require tax refunds to be deposited into an account only in the name of the individual listed on the tax return.” The IRS has resisted that, presumably because of cost, but it seems an unfathomable oversight. George also recommended that the IRS limit the number of deposits into the same account and that the Treasury require financial institutions to verify the identity of debit card purchasers.

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When our system makes fraud so simple, the reason is often that Congress prefers to make life here easier for illegal immigrants. Would any aspect of solving the fraud problems harm illegal immigrants who want to file tax returns to recover their withheld income tax payments? Especially given that many of these people use social security numbers that belong to US citizens? If so, that’s the reason the problem has not been solved.

The only bipartisan agreement on immigration is that the law should pretend to prohibit it but that people who immigrate illegally should not be treated as criminals. Instead, every possible means should be provided to accommodate those who break the immigration laws but behave approximately lawfully otherwise. This hypocritical arrangement allows politicians to support both sides of this vexing issue.

If $5 billion in tax fraud is part of the price to maintain this fictional limitation on immigration, I’m sure it’s a price a majority of our politicians are willing to pay. If the tax fraud issue is unrelated to immigration, then it’s just plain stupid. We’ve seen plenty of stupidity from Congress over the years, so that would not be surprising either.

I can’t see what this has to do with undocumented workers. The tax system makes money on them because they pay payroll taxes with little hope of ever receiving benefits.

The refund fraud is just plan old theft, It would be easy to deter without creating any new burdens on compliant taxpayers, but it would cost some money and access to the jobs database that Congress has so far denied to the IRS.

The correct way to attack this problem would be to solve it with less bureaucracy and less cost. A simpler tax structure and collection process could be developed. Throwing more money after bad which is exactly what happens when any more of our citizens money is funneled to the government just creates more problems. This entire article is just a call for expanded government. Perhaps the best solution would be for everyones income to be sent directly to the government and allow them to send what they feel each of us deserves.

Thanks for the reply, Len. Any connection would be tenuous, but here is my thinking. You state “TIGTA identified 48,357 SSNs that were used multiple times on tax returns. Some of these are simple mistakes—transposing digits, for example—but many if not most represent identity theft cases.”

People working illegally typically use another person’s SSN. If the illegal worker has federal income tax (not just OASDI or Medicare tax) withheld, that worker might file a tax return to collect a refund of the excess and perhaps to qualify for EITC. Use of another person’s SSN in these cases is qualitatively different from both refund fraud and classic identity theft for profit. I don’t know how the law could account for that distinction, but I’m sure the distinction is very important to advocates for illegal immigrants. (I resist calling them undocumented because they presumably have access to legitimate documents from their native countries; it’s just that those documents are not useful in obtaining work in the US.)

A compassionate law would somehow need to distinguish between a person who files one return using an illegitimately obtained SSN in order to access withholding he actually paid and a person who files dozens of refund claims for money he never paid. Complete loss of withheld income taxes would be an inequitable penalty for working in the US illegally. It would also unduly reward working off the books rather than on the books, unless there is a twist of economic incidence I have not thought through.

Christopher, Good point (except for the snarky bit at the end). Tax reform could help a lot. A significant problem is that Congress asks the IRS to do more and more while never giving them resources to administer all the subsidy programs under its jurisdiction. But even a super simple tax system would be susceptible to fraud and giving the IRS resources to go after that fraud would lower the burdens on the vast majority of citizens who try to comply (either because they’d pay lower taxes now or their kids would inherit less debt). To me, this seems like an easy call–much easier (politically, at least) than going after favored tax breaks.

Len, the economic incidence comment was a genuine attempt to allow for the possibility that I overlooked something. As you know, when you and I disagree, you always turn out to be correct.

There’s another variety of tax refund fraud that appears to have the unofficial endorsement of leading Democrats: http://www.nationalreview.com/blogs/print/301232

That’s the situation which originally had me wondering whether thwarting identity theft would harm illegal immigrants who then illegally collect Earned Income Tax Credit money. This practice does have support among many legislators although the public definitely opposes it.

My guess is that we will soon see legislation to thwart both of these schemes. The bad news is that the reason for doing so will be that Congress wants to book 10 years of savings and spend it all immediately.

Buff, Thanks for highlighting Vitter’s op ed. I think the issue is a bit more nuanced than Vitter makes it out to be. Center for American Progress (a liberal think tank) responded here. There’s a legitimate issue about whether children of undocumented immigrants who are in the country legally should be entitled to benefits such as the child tax credit. (I guess there’s also an issue about whether the credit benefits the child or the parent.) I think it’s more an immigration debate than a tax debate. But the IRS should definitely go after that form of fraud.

Historical note: The child tax credit was part of Newt Gingrich’s Contract with America so it does have strong bipartisan roots.

yes it is stupidity and the problem does not lies with fictional limitation on immigration. I dont see a single argument supporting this theory of right society can stop crime , problem lies the with the system is not profesionally build and run…all stupid beauraucrats or mischievously not stupid

My friend, the solution does not lies on hiring more horses to run the cart rather it must be steered by a right single man or a policy committee on the IRS e-filing system. it is to my amaze who will first come will get first …oh my God ,,,,damn it….its like whore one who gets first errected will go first belongingness , identity, integrity , unigueness of process, name etc,,,where all the science of IT management has gone ..

As a casual observer, it seems to me that there are a host of straightforward solutions and that it would be easy to calculate whether the improvements save taxpayers money. Clearly the database limitations and restrictions — particularly those based on legislation instead of technical issues — should be examined. Will @ssed speculation here … is there a privacy issue here? I can’t think of one off the top of my head; but I’m wondering what is slowing the process.

Are there private bank accounts that legitimately receive multiple refund checks? There are tax return preparers who loan money out to folks and get the tax payer’s checks directly. Anyone else? Perhaps there would be a way to administratively handle this by associating EINs to particular bank accounts.

I wonder how much theft could be prevented by giving the IRS say … another two weeks to pay refunds?

Anyway, it seems silly to leave so much money on the table when a few steps could curb the theft.